Moody’s downgrades Sri Lanka’s rating to Caa2; CBSL questions timing & subjectivity

Moody's Investors Service ("Moody's") has downgraded the Government of Sri Lanka's long-term foreign currency issuer and senior unsecured debt ratings to Caa2 from Caa1 under review for downgrade. The outlook is stable.

"The decision to downgrade the ratings is driven by Moody's assessment that the absence of comprehensive financing to meet the government's forthcoming significant maturities, in the context of very low foreign exchange reserves, raises default risks," Moody's said in a statement.

"In turn, this assessment reflects governance weaknesses in the ability of the country's institutions to take measures that decisively mitigate significant and urgent risks to the balance of payments."

However, releasing a statement, the Central Bank questioned the timing of the rating action as the downgrade came a few days before the budget for 2022.

"It also reflects serious governance weaknesses of such agencies, where they systematically overlook the positive developments and expectations in emerging market economies, but attribute much greater weight to downside risks," the Central Bank said.

"Moreover, the assessment exposes the rating agency’s ignorance on the well-established political stability within a democratic setup, when it claims about governance weaknesses and challenging domestic political environment."

Moody's, however, sees limited prospects for meaningful expenditure cuts, implying still wide fiscal deficits of 8.0-8.5% of GDP in 2022-23, compared to an average of 5.7% over 2016-19.

Moody's has also assumed that Sri Lanka will not participate in a financing programme with the International Monetary Fund or other multilateral development partners for the foreseeable future, while international bond markets remain prohibitive as a source of external financing.

Heightened liquidity risks are compounded by Moody's expectation that the government's fiscal deficit will remain wide over the next few years, which will keep borrowing needs high and remove fiscal flexibility.